What Is an Equity Grant? RSUs, ISOs, NSOs, and Taxes

An equity grant is a form of compensation that gives you an ownership stake in the company you work for, delivered as shares of stock or as the right to buy shares at a locked-in price. Companies use equity to keep employees invested in long-term growth while conserving cash, so the value of your award rises and falls with the stock price. Almost every grant comes with a vesting schedule, which means you have to stay (or hit certain targets) before you actually own anything.

How Vesting Works

Every grant starts with a grant date. That date sets the terms of your award: how many shares, what type, and the price reference for any options. It is not when you own the equity. Ownership comes through vesting.

Most companies use time-based vesting on a four-year schedule with a one-year cliff. The cliff means you get nothing if you leave before your first anniversary. Once you pass that mark, a chunk of the grant (often 25%) vests at once, and the rest typically vests monthly or quarterly over the remaining three years. Walk out before the cliff and you walk out empty-handed.

Some grants use performance-based vesting instead, tying your equity to revenue goals, stock price milestones, or other operational targets. A few plans combine both, requiring a service period and specific numbers. Once shares vest, you own them outright (for RSUs and RSAs) or can choose to buy them (for stock options).

The Main Types of Grants

Restricted Stock Units

RSUs are the most common equity grant at publicly traded companies. An RSU is a promise to deliver actual shares once you satisfy the vesting requirements. You pay nothing to receive them. When RSUs vest, the company deposits shares in your brokerage account, and the full market value counts as taxable income. Some plans also credit dividend equivalents, cash or extra shares matching dividends paid to regular shareholders, which are taxed as ordinary wages when paid.

Stock Options: ISOs and NSOs

A stock option gives you the right to buy a set number of shares at a fixed price, called the exercise or strike price. That price is almost always the stock’s fair market value on the grant date, so the option is worthless until the stock rises above it. The difference between the current price and your strike is called the spread, and it is your potential profit.

Incentive stock options (ISOs) are available only to employees and carry special tax advantages if you follow certain holding rules. Federal law caps the amount of ISOs that can become exercisable for the first time in any calendar year at $100,000 of stock, measured by fair market value on the grant date.¹ Anything above that automatically converts to non-qualified stock options. ISOs also expire no later than 10 years from grant.²

Non-qualified stock options (NSOs) don’t meet the statutory requirements for ISOs under Section 422 and don’t receive the same tax benefits. The trade-off is flexibility: NSOs can be granted to contractors, advisors, and board members, not just employees.

Restricted Stock Awards

A restricted stock award (RSA) differs from an RSU in one important way. You receive actual shares on day one. You own the stock, can vote it, and may receive dividends. But the shares are restricted, so if you leave before vesting, the company buys back your unvested shares, typically for whatever you paid (often nothing). RSAs are most common at early-stage startups where the stock has a low current value.

How Each Grant Type Is Taxed

Tax treatment varies sharply, and the timing is rarely intuitive. The general federal rule is that when you receive property for performing services, you owe income tax once that property is no longer at risk of forfeiture.³ Each grant type hits that trigger differently.

RSUs

RSUs create a single taxable event: the vesting date. When shares are delivered, the full fair market value counts as ordinary income, subject to federal income tax, state income tax, Social Security, and Medicare. Your employer reports the income on your W-2, just like salary.

Most companies use sell-to-cover, automatically selling enough newly vested shares to pay withholding. The catch: federal supplemental wage withholding is a flat 22% (or 37% if your total supplemental wages exceed $1 million for the year). If your actual marginal rate is higher, the withholding won’t cover your full liability. Employees receiving large RSU grants in the 32% or 35% bracket often discover a five-figure gap at tax time. Run the math when shares vest and set aside the difference, or make estimated tax payments.

After vesting, your cost basis equals the fair market value on the vesting date. If you hold and sell later at a higher price, the additional gain is a capital gain. Selling within a year of vesting produces a short-term gain taxed at ordinary rates; holding more than a year qualifies for long-term capital gains rates.⁴

NSOs

NSOs are taxed in two stages. At exercise, the spread between the current market value and your strike price is ordinary income reported on your W-2. Your employer withholds taxes on that amount, and the same supplemental withholding gap applies.

The second stage happens when you sell. Your cost basis is the market value on the exercise date, and any gain above that basis is a capital gain. Shares held longer than a year after exercise qualify for long-term capital gains rates, which for 2026 are 0% for single filers with taxable income up to $49,450, 15% up to $545,500, and 20% above that.⁵ Shares sold within a year are short-term gains at your ordinary rate.

ISOs

ISOs offer the best tax deal in equity compensation, but only if you follow two holding rules: hold the shares at least two years from grant and at least one year from exercise.² Meet both and the entire gain from strike price to sale price is taxed as a long-term capital gain. No ordinary income tax at exercise. No payroll taxes on the spread.

The trap is the alternative minimum tax. When you exercise ISOs and hold the shares rather than selling immediately, the spread between strike price and market value is an AMT preference item. You may owe AMT even though you haven’t sold anything or received any cash. For 2026, the AMT exemption is $90,100 for single filers and $140,200 for married couples filing jointly, phasing out at $500,000 and $1,000,000 respectively.⁶ If your AMT calculation exceeds your regular tax, you pay the higher amount. AMT rates are 26% on the first portion of alternative minimum taxable income and 28% on income above $244,500.

There is a silver lining. AMT paid because of an ISO exercise generates a minimum tax credit you can use in future years when regular tax exceeds tentative minimum tax. The credit carries forward indefinitely, and you claim it on IRS Form 8801.⁷ Most people recover it gradually over several years after selling the ISO shares. Model the AMT before you exercise. Whether to exercise and hold for capital gains treatment or exercise and sell immediately to avoid AMT depends on your income, the size of the spread, and how much appreciation you expect during the holding period.

Sell ISO shares before satisfying both holding periods and the transaction becomes a disqualifying disposition. The lesser of the actual gain or the spread at exercise gets reclassified as ordinary income, with any remaining gain taxed as a capital gain based on how long you held the shares. Your employer reports the exercise on Form 3921.⁸

The 83(b) Election for Restricted Stock

If you receive a restricted stock award, you can file an 83(b) election to pay income tax immediately on the current value rather than waiting until the shares vest. The filing is due to the IRS within 30 days of receiving the shares, and the deadline is absolute.⁹ Miss by a day and the election is gone forever.

You’re betting the stock will be worth much more when it vests. File on stock worth $1 per share and you pay ordinary income tax on $1 per share now. If the stock is worth $50 when it vests three years later, you’ve already paid ordinary tax at the lower value, and the $49 of appreciation is taxed at long-term capital gains rates when you eventually sell.

The risk is real. If you file an 83(b) election and later forfeit the stock because you leave, the statute explicitly bars any deduction for the forfeiture.³ You paid tax on income you never kept, and you don’t get it back. The only deduction available is a capital loss limited to what you actually paid out of pocket, which for many startup grants is zero. File the 83(b) only when you’re reasonably confident you’ll stay through vesting and the current value is low enough to lock in.

Exercising Stock Options

Once options vest, exercising means buying the shares at your locked-in strike price. RSU holders skip this step because shares are delivered automatically at vesting. Option holders have to decide how to fund the purchase.

Cash exercise. You pay the full strike price out of pocket and keep all the shares. For ISOs you intend to hold for long-term capital gains treatment, cash exercise is the standard approach because no sale is triggered.
Sell-to-cover. Your broker sells just enough of the newly acquired shares to cover the strike price and tax withholding, depositing the rest in your account.
Cashless exercise. The broker sells enough shares to cover strike price, taxes, and fees, and you receive the net cash or remaining shares. The most popular method for NSOs because it requires zero out-of-pocket cash.
Net exercise. The company withholds a portion of your option shares to cover the strike price. Private companies sometimes offer this when there’s no public market.

Every exercise method for NSOs triggers ordinary income tax on the spread. The choice between methods is about cash flow and how many shares you want to keep, not the tax outcome.

What Happens When You Leave

Unvested equity vanishes when you walk out the door. If you haven’t passed the cliff or finished your vesting schedule, those shares or options are forfeited. The complications involve your vested equity.

Vested stock options typically come with a post-termination exercise period, often 90 days but sometimes shorter. Your grant agreement specifies the exact window. Miss it and vested options expire worthless, no matter how deep in the money. For ISOs, there is an additional federal constraint: you must exercise within 90 days of leaving to preserve ISO tax treatment. Exercise after day 90 and the options automatically convert to NSOs, so the spread becomes ordinary income subject to payroll taxes.²

Some companies extend the post-termination window to several years, but any extension past 90 days converts ISOs to NSOs regardless of what the plan says. The company can give you more time; the IRS will not give you the ISO benefit.

Termination for cause is worse. Many equity plans allow the company to cancel both vested and unvested options for misconduct, and some include clawback provisions requiring you to repay the value of previously exercised equity. Read your grant agreement carefully before assuming vested means untouchable.

Vested RSUs that have already been delivered as shares are yours, and the company cannot pull them back absent a clawback clause tied to specific misconduct. Unvested RSUs are forfeited on your last day.

Acquisitions add another layer. Some grants include single-trigger acceleration, vesting some or all of the remaining shares when the deal closes. Double-trigger acceleration, which is far more common, requires both the acquisition and your termination (or a significant role change) within a defined period afterward, usually 9 to 18 months.

Selling Restrictions and Private Company Liquidity

Owning vested shares doesn’t always mean you can sell. Public companies impose blackout periods, typically starting two to three weeks before quarter-end and lasting until a day or two after earnings are released. During a blackout, employees covered by the insider trading policy cannot buy or sell company stock. Roughly 85% of large public companies apply these quarterly restrictions to directors, officers, and designated employees.

If you’re an affiliate of the company (an executive officer, director, or major shareholder), SEC Rule 144 limits how much stock you can sell. The cap during any three-month period is the greater of 1% of outstanding shares or the average weekly trading volume over the prior four weeks.¹⁰

Private company equity is a different problem. There is no public market, so shares may be illiquid for years. Some companies run periodic tender offers, letting employees sell shares back to the company or to outside investors at a set price. Others permit direct secondary sales, though the company usually holds a right of first refusal that can block or match any sale. Until the company goes public or is acquired, your equity may be valuable on paper but practically inaccessible as cash.

Tax Reporting Pitfalls

Cost Basis Errors on Form 8949

When you sell shares acquired through equity compensation, your broker reports the sale on Form 1099-B. The cost basis reported there frequently does not include the ordinary income you already paid tax on at vesting or exercise. Transfer the 1099-B numbers straight to your return without adjusting and you’ll pay tax twice on the same income. Correct it by reporting the sale on Form 8949 with an adjustment in column (g) to reflect your actual cost basis, which includes the income already taxed.¹¹ This is where most equity tax returns go wrong, and it almost always results in overpaying.

The Wash Sale Rule and RSU Vesting

The wash sale rule disallows a tax loss if you buy substantially identical stock within 30 days before or after selling at a loss.¹² RSU vesting counts as acquiring new shares. If you sell company stock at a loss and new RSU shares vest within that 61-day window, the loss is disallowed and added to the basis of the newly vested shares. Even sell-to-cover transactions on a vesting date can trigger wash sale issues. If you plan to harvest tax losses on company stock, check your vesting calendar first.

Section 409A Penalties

Section 409A governs deferred compensation, and stock options at private companies are the most common place it bites. If the company sets the exercise price below fair market value (often because it skipped or botched its 409A valuation), the options are treated as noncompliant deferred compensation. The penalty falls on you, not the company: at vesting, the deferred compensation is included in your gross income, hit with a 20% additional tax, and assessed interest calculated from the date the compensation first vested at the underpayment rate plus one percentage point.¹³ If you’re joining a private company and receiving options, asking whether the company has a current 409A valuation is a reasonable, self-protective question.

The Documents That Control Your Grant

Two documents govern your equity, and most employees never read either. The stock incentive plan is the master document approved by the company’s board and shareholders. It sets the total share pool, eligibility rules, and the boundaries for every individual grant. Your equity grant agreement is the contract between you and the company, specifying the number of shares or options, the grant date, the exercise price for options, and the vesting schedule.

Pay close attention to the forfeiture and clawback provisions in both documents. Clawback clauses allow the company to recover previously vested equity, sometimes years after you received it, under circumstances like executive misconduct, material restatement of financials, or breach of a non-compete. These provisions are increasingly common and increasingly aggressive. The grant agreement also governs your post-termination exercise window and any acceleration rights in a change of control, so read it before your first batch of options vests rather than the day you clean out your desk.

1
eCFR. 26 CFR 1.422-4 – $100,000 Limitation for Incentive Stock Options
2
Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options
3
Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection with Performance of Services
4
Internal Revenue Service. Topic No. 409 Capital Gains and Losses
5
Tax Foundation. 2026 Tax Brackets and Federal Income Tax Rates
6
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
7
Internal Revenue Service. Instructions for Form 8801
8
Internal Revenue Service. About Form 3921, Exercise of an Incentive Stock Option Under Section 422(b)
9
Internal Revenue Service. Form 15620 – Section 83(b) Election
10
Securities and Exchange Commission. Rule 144: Selling Restricted and Control Securities
11
Internal Revenue Service. Instructions for Form 8949
12
Office of the Law Revision Counsel. 26 U.S. Code 1091 – Loss from Wash Sales of Stock or Securities
13
Office of the Law Revision Counsel. 26 U.S. Code 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans